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The Truth About Small-Business Credit
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Article 4: Get Credit From a Bank
Banks exist to lend money. But just when should you borrow money from them? And how much borrowing is too much?
You should have a legitimate purpose for borrowing money. One is the funding of capital investments such as business equipment and buildings. The revenue expected to be obtained from the use of the acquisitions should be higher than the cost of credit in terms of interest payments.
It’s also valid to borrow money to fund rapid growth.
“Working capital is an issue that faces every business,” says Robert S. Bernstein, partner at the Pittsburgh-based Bernstein Law Firm.
“As business ramps up, investment in inventory and raw materials and production costs is made at a faster rate than the revenue is recognized. The cash has to come from somewhere. Either you save up or go to a lender.”
In such cases, though, the need for funds must be balanced against an assessment of the certainty of future revenues.
“It’s OK to borrow money to fund growth so long as it’s clear that the growth is going to turn into revenue,” points out Bernstein.
Another legitimate purpose for borrowing is to fund delays in cash flow when customers don’t pay you as quickly as you would like. The challenge here, though, is to accumulate a track record sufficient for the accurate prediction of inbound cash.
“When you are brand new, it is foolish to borrow as much as you qualify for without any track record upon which to base your expectations,” warns D. Brent Wells, a certified creditors rights specialist and president of Wells & Cuellar, a Houston-based law firm that helps businesses design efficient credit programs.
Loans should generally not be used for recurring expenses.
“If you find you are covering fundamental expenses like payroll and taxes by borrowing, then you are in the zone of borrowing too much,” warns Wells, who adds that it’s easy to end up in a cash squeeze.
Bear in mind that getting a loan can take time, and in an emergency you may not have the luxury of waiting. So even if you don’t need money right now you should prepare for the day you do.
“You should get a line of credit in place for use down the road when you might need money,” advises Myles H. Alderman, Jr., partner with the Hartford law firm of Alderman & Alderman.
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